Falling prices for North Coast excess grapes and wine may lead to write-downs
A big correction in the prices for excess North Coast grapes and wine is not only making it potentially more challenging for vintners to tap working capital but also raising the possibility of having to write down inventory.
After the Business Journal talked with wine industry bankers about the impact on collateral value for lines of credit because of lower prices on the grape spot market (available for purchase from year to year) and bulk wine market, we talked with local accounting experts on how these changes would affect how they report the value of inventory.
“We would be asking our clients to take a look at their inventory of bulk wine as well as bottled wine, how they're going to use that in their programs and sell in the marketplace, then where necessary, take an accounting adjustment,” said Carol O'Hara, CPA, partner in charge of BPM's North Bay team.
Under the Financial Accounting Standards Board's U.S. generally accepted accounting principles, or GAAP, inventory is valued on the balance sheet at the lesser of cost or net realized value. The latter is what similar bulk or bottled wine would sell for on the market, less the costs that went into getting either to the point of sale, such as putting wine in bottles.
So if there were $25 of costs that went into each excess bottle of wine, but it would fetch less than that if sold, the vintner would write down cost of goods sold, O'Hara said. And if the winery decides to forego the cost of putting bulk to bottle then finding a buyer, the excess wine could be sold in bulk to another vintner.
But because the bulk-wine market right now is in oversupply, vintners with commitments to purchase more grapes than projected bottle sales are expected to suck up are seeking workouts with growers for existing grape contracts, O'Hara said. Some have transferred to other vintners.
“Selling on the bulk market is probably the least attractive alternative right now,” O'Hara said.
BULK WINE MARKET CORRECTION
That's because slackening demand for wineries' liquid gold available in sale in bulk has sent pricing in that market falling from the heights seen in the North Coast in 2016-2018, according to brokers of such wine and grape contracts.
In December 2018, excess Napa Valley cabernet sauvignon wine was selling in bulk for $25–$40 a gallon, with wine from the best appellations priced at the top end of that range, but in February 2020 it was selling for $18–$25, according to Turrentine Brokerage. Pinot noir from the choice Sonoma Coast and Russian River Valley regions was selling for $12–$14 a gallon at the end of 2018, with top-end vintage 2017 pinot fetching $2 more a gallon, and is now going for $7–$9. And chardonnay from those Sonoma County subappellations went from $12–$15 to $7–$9.
“Everybody will need to get a handle on what they're doing, what their intended use is, not just at this point in time but going forward for a few years, whether they can utilize all the supply that they have and any resulting impact on the net realizable value,” O'Hara said. “You can't assume that that you're going to be able to sell it all. You may have to deep-discount it or come with some alternative strategy and pricing.”
Vintners have been anticipating potential inventory write-downs from the supply situation for months, as financial teams for wineries with Dec. 31 fiscal year-ends prepared for audits of their books, according to O'Hara. So even before the 2019 harvest, a number of BPM clients had been working to transfer grape contracts for excess fruit.
WHAT ABOUT LIFO?
One of the challenges of a situation where net realizable value for inventory is falling comes with which inventory cost accounting method vintners are using, according to Michelle Crosbie, director of the tax department in BPM's Santa Rosa office.
“A lot of wineries are using a LIFO inventory method, which prevents them from taking those lower-of-cost-or-market write-downs,” Crosbie said. With bonus depreciation available through the 2018 federal tax cuts, a number of wineries in the past two tax years have been filing for a change in accounting methods to a cash base for inventory. “I can't say switching to a cash base is going to make that better, but it does accelerate (depreciation for) a big chunk of expenses that are sitting in your inventory.”
Wineries are allowed to expense that in one year, then going forward as long as the bonus depreciation is available the inventory costs could be expensed, bringing down cost of goods sold and improving cash-basis income, she said.
Jeff Quackenbush covers wine, construction and real estate. Contact him at email@example.com or 707-521-4256.